NAIOP/SIOR Midyear Reviews Show Solid 2014

BOSTON — At NAIOP/SIOR’s Midyear Market Roundup held this month at the Seaport Hotel, a sizzling urban leasing market and welcomed prediction by economist and keynote speaker Hans Nordby that “it looks like a very good ride for Boston in the next few years” were just part of the good news emerging from NAIOP and SIOR’s annual shared event that featured a lineup of top industry professionals. Rent growth in key suburban office submarkets, metropolitan Boston’s 96 percent apartment occupancy rate and an investment sales market approaching record highs in pricing were also reasons for continued optimism in this current cycle.

In his presentation to the packed room, Jones Lang LaSalle Managing Director Matthew Daniels told a tale of two very different suburban environments. The first, which he dubbed the “Fortress Market,” is the 18.8 million sf stretching from Needham to Woburn along Route 128, an inventory that comprises just 20 percent of the total suburban supply. With a singledigit vacancy rate and robust rent growth, best-in-class office buildings in this stretch are attracting a diversified group of tenants large and small to fill the buildings with institutional capital in hot pursuit once they are stabilized, as evidenced by the number of CRE sales transactions to date in 2014 after an unprecedented 2013.

Then there is the other 80 percent. The remaining 70 million sf has a vacancy rate of about 19.0 percent where it has historically been around 15.5 percent, according to Daniels. “A lot of that has to do with more of the older product becoming functionally obsolete,” he explained, adding that the lack of sufficient parking and limited access to amenities are also drags on those buildings chances of being reborn.

The Fortress market has been averaging 370,845 sf of annual net absorption— double the amount for the rest of the market— and year-over-year rent growth was 7.4 percent for the preferred submarkets, with much of the growth fueled by technology companies. “While there’s no doubt that tech tenants are moving into Boston and Cambridge, tenants like Trip Advisor, TomTom and Black Dog Software continue to grow in the suburban marketplace and recruit, and they are going to the trophy quality product in the market,” Daniels observed. The laboratory market is also vibrant in the suburbs, he reported, specifically Lexington and Waltham, and he adds the defense industry is also a major player, particularly ISR (intelligence, reconnaissance, and surveillance). “Which is significant because it’s the only line item not being cut from the defense budget these days,” Daniels noted.

While the vacancy rate of 9.8 percent in the Fortress Market is down from 13.8 percent in 2008, rents have still not returned to pre-recession levels. Rents for Class A product now average $31.10 per sf in the Fortress, and that is still 10.0 percent below 2007. “It’s one of the reasons we firmly believe there will be rent growth in this market, and we also believe there will be rent growth in the outer markets as well,” Daniels predicted. Currently rent growth in the “other” market is pocketed and specific to individual assets, he says. Reasons voiced for optimism is the lack of large blocks of space in Boston and Cambridge coupled with affordability. “Although we do see tenants going into the Downtown Boston/Cambridge from suburbia, we have a huge price break, which is about as wide a gap as we’ve ever had, historically speaking,” said Daniels.

And Boston and Cambridge are not the only markets with cranes in the air. There is new product coming on line as well as redevelopment at some of the older parks. Four Burlington Woods, a boutique 100,000 sf office complex, is being developed by the Gutierrez Cos. in Burlington. National Development and AEW Capital are doing a makeover of New England Executive Park, and it will be “transformative to the entire marketplace. The retail they will be announcing in the fall is just incredible,” said Daniels. Meanwhile, a pair of mixed use projects is under construction in Waltham, 1265 Main St., with its 120,000 sf of office space; and 10-20 City Point, being developed by Boston Properties (400,000 sf of office space and rumored to be halfcommitted to Wolverine Worldwide).

Multi-Family

While the lack of affordable housing for the Commonwealth’s growing workforce is a concern, news on the multifamily front is certainly good for developers and landlords. Christopher Sower, Managing Director & Partner at Boston Realty Advisors, reported that the vacancy rate across the metro Boston apartment market (inside Interstate 495) is at a scant 3.9 percent and that the condominium market is continuing to gain traction. “From a rental and capital markets perspective, we’re seeing a very tight and efficient market,” said Sower. “The apartment and condo market is undersupplied at the moment with very tight vacancy, and there are strong rental growth projections going forward.”

Apartments in the central city submarket (Back Bay, Beacon Hill, Financial District, South End and Seaport) are averaging close to $3,000 per month with a vacancy rate of 3.7 percent. Rents are slightly lower in Cambridge and Watertown, and Brighton/Brookline has about a 2.5 percent vacancy rate, so there is very little available inventory for renters, putting upward pressure on rents, outlined Sower.

In terms of capital markets, “Boston is known nationally as one of the top three markets where (investors) want to be, so there’s a ton of capital that’s coming into our market that wants to be here in the urban core, and wants to be downtown,” Sower reported. “The only problem is that we don’t have a lot of inventory that trades in that space.” As a result, only about $500 million of product closed in the first quarter, with the majority of deals in the Route 128/I-495 submarkets. The average capitalization rate for those transactions across all asset classes was about 5.2 percent for deals over $5 million. “Cap rates are getting aggressive, as is the price per pound for a trade,” Sower observed. The multifamily veteran added that BRA is currently marketing a 150-unit property in Allston that he anticipates will crest $530,000 per unit.

In Cambridge and Somerville, the price for multifamily properties has gone over $450,000 per unit, and Maxwell Green, a 184-unit apartment complex in Somerville, recently traded for $87 million ($470,000 per unit at a 4.4 cap rate). Sower added that suburban deals are trading at much higher average deal size compared to the urban core assets, but the cost per urban unit is double that of the suburbs, with an 85 basis point gap between cap rates for the markets.

The condo revival has been unmistakable, Sower relayed, with Millennium Place selling 256 condo units in one year (25 to 30 units per month), and the Ink Block stock is already 50 percent sold. And investors are converting apartment units and outmoded office space into condos. “We are seeing the condo converters coming back very strongly (to the Back Bay/Beacon Hill markets). They’re coming back with smaller deals to start, but the four deals that traded in the Back Bay so far this year have all traded as condo conversions,” said Sower. Many buildings are being gut renovated, and Sower reports that Back Bay/Beacon Hill units are getting over $2,000 per sf, “which has not been seen in Boston for a long time.”

The CRE segment that has been garnering all the headlines in 2014 is investment sales, and Edward C. Maher Jr., Vice Chair of Cushman & Wakefield’s Capital Markets Group, delivered a spirited overview of the white hot market. “The only bold prediction that I’m making is that 2014 is going to blow 2013 out of the water,” began Maher. “It is also not the worst time in the world to be a seller. For those on the buyer side of the equation, however, it’s a completely different story, with cap rates in Boston and Cambridge in the fours and fives, Route 128 in the sixes and the deeper suburbs in the 7, 8 and 9 (percent) range. It’s a painful experience (for buyers).”

With near record prices per sf being achieved for core buildings and in select suburban markets, Maher said gauging the metric is completely unpredictable, and postulated, “I can honestly say that myself or anyone in my office or anyone who does what I do for a living cannot tell you what any single building in Greater Boston is worth right now. No clue,” he said. “Pricing movement is pretty much unprecedented right now. The worst thing you can do is tell an investor that they’re out, because then they’ll increase their offer to get to the next round.”

Maher identified five trends occurring in the market right now, beginning with what his colleague Robert E. Griffin Jr. has dubbed “cool core” to describe the renovated brick and beam structures in the North Station and Seaport districts that are attracting tenants aiming to recruit the millennial workforce. Maher used a C&W listing at the Seaport’s 51 Melcher St. (where Life is good and WeWork are located) and 226 Causeway St. in North Station as prime examples. Synergy Investments sold 51 Melcher St. to Zurich North America for $53 million (at a 5 percent cap rate) after acquiring the building for $10.5 million and investing $7 million in renovations. C&W is also marketing 226 Causeway St. “When we sold 226 Causeway to Spear Street Capital in the fall of 2011 (for $43 million) everybody, including us, thought they were nuts. And we’re going to get north of $800 (per sf). This is Exhibit A of cool core being accepted by institutional investors,” Maher explained.

Other trends Maher detailed include a sharp demand for transit-oriented assets, re-emergence of the suburban trophy properties, an increased appetite for value add buys, and the importance that tenants are placing in occupying space that attracts millennials.